Morning Report: Weak CPI ignites a stock and bond rally

Vital Statistics:

Stocks are higher after a weaker-than-expected CPI print. Bonds and MBS are up big.

Inflation was flat month-over-month in October, according to the Bureau of Labor Statistics. The number was driven by an increase in shelter, which was offset by a decline in gasoline. On a year-over-year basis inflation rose 3.2%.

If you strip out food and energy, inflation rose 0.2% month-over-month and 4% year-over-year. Both the headline and the core inflation rates came in below expectations, which drove a big decrease in the 10 year yield, taking it down to the lowest level since late September.

This print, along with the weaker-than-expected jobs report shows that the Fed’s tightening policies are having the desired effect. With UBS introducing a call for 275 basis points in easing next year, the discussion over Fed policy is now starting to consider the possibility that the Fed has over-shot. Given that 525 basis points in rate hikes over 18 months is one of the most aggressive tightening cycles on record, it does need to be part of the conversation.

The Fed Funds futures have taken any further rate hikes off the table. They are forecasting no change at the December and June meetings, and a 28% chance of a cut at the March meeting.

Small Business Optimism declined in October, according to the NFIB. Business is seeing weakened demand, with a net negative 17% of business owner reporting lower sales over the past 3 months. This is down dramatically from September and is the lowest reading since July 2020. Despite the drop in demand, inflation remains the single biggest concern, with a net 30% of small businesses raising prices.

In the commentary, the NFIB discusses how we could have such low sentiment when GDP grew at 4.9% in the third quarter. The first explanation is that the growth rate will be revised downward. That is a possibility. However if you look at the components of GDP growth a lot came from inventory build. Inventory buildup is generally what causes recessions in the first place, as companies cut production in order to move the merchandise which triggers layoffs. Given the data about sales and inventory build the fourth quarter is looking to be weak.

The economy has also been supported by government spending, which is often called “junk GDP” since it is largely artificial and doesn’t represent real, sustainable demand.

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